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Last quarter it appeared Google sold about million Nexus 7 (HT to Om Malik for doing the math first). Unlike Apple, Google does not break down the device sales. But Google is required to disclose all revenues and their sources (however cryptic) in its financial statements. So Om looked at the non-Ad revenue category (what Google classifies as “Other Revenues”) and attributed it to Nexus 7. Later I merely refined it taking into account growth trend in Other Revenues before Nexus 7.

Last quarter it appeared they sold one million Nexus 7 and at cost, bringing almost no operating profit from the Nexus 7 line. Using the same math here is what this quarter looks like, (source Google)

Other Revenues went from $666M last quarter to $829M (the quarter before, Q2, it was $429M)

That is a growth of $163M for this quarter and a total of $410M from Q2

If you account for the fact that Other Revenue was growing 5% even before Nexus 7 line, not all this growth came from Nexus 7. That knocks out $43 M (two quarters of 5% growth of $429M)

So Other Revenues attributable to Nexus 7 comes to $206M last quarter (Q3) and $356M this quarter (Q4)

At Average Selling Price of $210 (assumption) it translates to 1.7 million units

One million in first quarter to 1.7 million Nexus 7 in second quarter. It appears Nexus 7 sales almost doubled in the second quarter but that is from very low levels to begin with.

After all it is the same flash, so why the price difference? Because costs have nothing to do with pricing. And Google knows, (perceived) value of additional 16GB flash is more to customers choosing nexus 10 than those choosing nexus 7 and is pricing accordingly. They also have higher reference price to work with compared to lower price point of Nexus 7.

Like this:

Summary: Google likely sold one million Nexus 7 last quarter but did not make a dime of profit from the sales.

I have presented similar such numbers for devices sold when companies do not release their numbers. Such analyses are based on the three accounting statements – balance sheet, income statement and cash flow statement, after all businesses are required to disclose all their revenues, expenses, inventories and cash flow.

Om Malik did similar analysis of Google’s latest earnings release. Om looked at earning statement line item on “Other Revenue” and how it jumped from $385M to $666M from same quarter last year and stated that Google likely sold million units of Nexus 7.

Other Revenues was $439M in Q2 and $666M in Q3. The difference $227M. But a look at past few quarters show Other Revenue is on the rise by about 5% every quarter. Accounting for that $21M growth, Google made additional $206M in unaccounted for Other Revenue which likely all came from Nexus 7 sales. At an ASP of approximately $210 that points to indeed million units of Nexus 7 sold.

The rule of accounting requires revenues from same period must be matched with costs incurred in the same period. Let us reconcile the cost of selling 1 million Nexus 7.

Google does not make it easy for us by itemizing Other Costs. The details are in the text of the 8-K but Google combines all of the Motorola COGS numbers which adds additional step to our math.

Other Cost of Revenues – Other cost of revenues, which is comprised primarily of data center operational expenses, amortization of intangible assets, content acquisition costs, credit card processing charges, and manufacturing and inventory-related costs, increased to $3.78 billion, or 27% of revenues, in the third quarter of 2012, compared to $1.17 billion, or 12% of revenues, in the third quarter of 2011.

In Q3 this was $3.78B of which $2.11B was from Motorola. So Google’s cost of revenues is $1.67B.

In Q2 this was $2.4B of which $1.029B was from Motorola. So Google’s cost of revenues is $1.371B. This is all their Cost of Revenue without Nexus 7.

The difference, $1.67B-$1.371B= $299M is unaccounted for. Not all could be due to Nexus 7, just like we did for revenues we should account for other growth.

The Other Cost of Revenue number in Q1 was $1.28B (no Motorola all Google). This is all their Cost of Revenue without Nexus 7. Assuming the same growth percentage from Q1 to Q2 applied to Q2 to Q3, the Q2 number including growth of other costs is $1.46B

So Cost of Revenues for Nexus 7 is $1.67B-$1.46B= $210M, same as the Revenue from Nexus 7.

Remarkable coincidence. May be not.

For one thing it confirms the math that Google most likely sold one million Nexus 7.

More importantly they are not making a dime from Nexus 7 sales, selling it at cost like Amazon is.

Like this:

Food Truck Race is a reality TV series on Food Network where contestants compete by selling food from their food trucks. Compared to other cooking contests, this series has very objective metrics- final sales dollars they are left with that decide who gets eliminated each week.

Contestants get seed money to buy first batch of raw materials but have to use part of revenue to buy more for producing more. You can see why just maximizing revenue is not the winning strategy but maximizing profit is. So they choose different products and pricing to maximize profits, mostly choosing premium products at premium prices.

The contestants became price takers whose only path to success consists of

Sell lots of products to lots of customers to maximize revenue

Cut costs – be it cutting a grilled cheese sandwich into four squares or using cheaper ingredients – to minimize costs

Practice unbundled pricing by charging for every extra

That is it. No branding, no positioning or no product versioning. In summary these became the price takers to an external entity.

There are two kinds of businesses – those who take active control of their pricing and get to set their own prices and those who react to price set by others, be it an Food Network TV show host or another player in the market.

Food Trucks competing with price limit may sound unrealistic but that is exactly what is happening in the low end tablet space. There is one price setter, Amazon with its Kindle Fire that set the $199 price point. As Henry Ford wrote in his autobiography, Amazon chose the price first and did everything to deliver a product at that price. While Ford added the importance of making a profit on the sale Amazon is focused on other ways to drive profit like making incremental sales through the device.

But the fact remains, Amazon is the price setter in this space. Anyone else entering the mini tablet market are forced to take the price set by Amazon, like the Food Truck Race contestants did. Even the mighty Google that practices perfect pricing with its AdWords network saw itself in the role of price taker. The fact that it is a superior product to Kindle Fire did not matter in setting its price.

Again looking at Food Truck episode,

Lime Truck, now in dire straits since they’ve spent all of their seed money on premium ingredients they were going to sell for $11 dishes, has to rethink the strategy. Quinn is later seen at the supermarket crumpling in the aisle bemoaning that they have “lost all of (their) integrity.”

That is correct, with Amazon as price setter, Google was reduced to the role of price taker, forced to rethink their strategy and in that process abandoning any plan they might have had for different pricing. In the TV show it was impossible to go against the set price and in real life it is almost impossible unless one can change the target segment, reference and product positioning. By targeting the same segment with same value proposition and positioning Nexus 7 in the same way Amazon positions Kindle Fire, Google is forced to take Amazon’s price.

Life is not fun being a price taker!

Finally, what about Apple and its much rumored iPad mini designed to compete in the 7″ tablet space created by Amazon and now expanded by Google?

Entering this segment would mean becoming the price taker or making an effort to become a price setter with a different price point.

By design, Apple has never been a price taker. In any market, the price setter gets to control its own profit while a price taker is at the mercy of market forces. Trying to become a price setter when there already is one requires Apple to either go low or just a bit higher. Either way, Amazon has set the price anchoring. The most likely scenario is a $299 price point for the iPad Mini.

For a business that actively takes control of its pricing it is highly unlikely they would give up that control for a new device. Revisit the three steps I listed for price takers. Apple already sells millions of premium price iPad at low enough cost and unbundles almost everything. How much more volume should they get and how much more costs can they cut to make profit from iPad mini?

If Apple indeed introduce iPad mini, expect them to position it much different from how Fire and Nexus 7 are positioned and hence become price setter for this category.